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China's currency just hit its lowest level in a decade. What's next?

China's battered currency is trading at its lowest point since the global financial crisis, leaving investor...

Posted: Oct 30, 2018 12:45 PM
Updated: Oct 30, 2018 12:45 PM

China's battered currency is trading at its lowest point since the global financial crisis, leaving investors asking how much farther it might fall.

The yuan sank past 6.97 to the dollar in Tuesday morning trading in Asia, its weakest level since May 2008. The currency has now slumped more than 9% against the greenback since January, dragged down by interest rate hikes in the United States, fears over the health of China's economy and the trade war between the two countries.

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The new 10-year low for the yuan came after indications Monday that the clash between Washington and Beijing is set to intensify. Bloomberg News alarmed investors with a report that the White House is considering more tariffs on Chinese goods by December if a meeting between US President Donald Trump and Chinese leader Xi Jinping doesn't go well. And the US government said it was restricting exports of American technology to a state-backed Chinese chipmaker.

The exchange rate is creeping closer to 7 yuan to the dollar, which is seen as a key psychological threshold for traders and could be the trigger for renewed attacks by Trump.

"Investors will be thrown out of their comfort zone," said Kevin Lai, a Hong Kong-based economist at investment bank Daiwa Capital Markets. "When it breaks seven, you're going to see a lot more selling pressure."

Sharp drops in the yuan can send shudders through China's economy and financial markets. In 2015 and 2016, huge sums of money flooded out of China as investors bet the yuan would keep falling, forcing Beijing to spend hundreds of billions of dollars to prop up its currency.

But analysts at research firm Capital Economics argue the Chinese government may now be less worried about the risk of money pouring out of the country than it is about the yuan's decline adding to tensions in the trade war with Washington.

Beijing wants "to avoid provoking the United States" ahead of Xi's expected meeting with Trump at the G20 summit next month, the analysts wrote in a note to clients Monday.

Trump has accused China of deliberately devaluing its currency as the trade conflict between the two countries has escalated — claims Beijing has repeatedly rejected.

The Chinese government on Friday issued a warning to speculators betting against the yuan, which is also known as the renminbi.

"For those who are trying to short the renminbi, we fought hand to hand a few years ago, so we are very familiar with each other," said Pan Gongsheng, deputy governor of the People's Bank of China, in Beijing on Friday. "I think it's still fresh in our memory."

China does have tools it can use to counter the currency's decline, including selling some of its huge war chest of US dollars.

The central bank "is likely to intervene to keep the pace of depreciation gradual," the Capital Economics analysts said. But they predicted the yuan would slip past 7 to the dollar soon, a level not seen since May 2008.

Other economists said they expect the yuan to touch the 7 mark several times before it clearly moves past it, allowing investors to get more comfortable. That way, "it will not create any surprise to the market when it happens," said Iris Pang, a China economist at Dutch bank ING.

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